Planning for Retirement: Your 401(k)

If you are thinking about retiring, getting close to retiring or recently retired, you’ll need to begin thinking about how to make the switch from living off of your paycheck to making the most of the money you’ve saved. 401(k) plans are the most popular type of retirement savings plans for employers in America. They offer flexibility and savings on a tax deferred, pre-tax basis to employees. Once you’re ready to retire, you’ll need a strategy to ensure that your savings will help you achieve the goals you’ve set for your post-working years.

Your 401(k) plan benefits begin once you reach age 59½. The law imposes an additional 10 percent tax on distributions before reaching that age. Required Minimum Distributions (RMDs) are partial annual payments required by the IRS. You must begin taking RMDs by April 1, following the year you turn 70½. If you wait until you are required to take RMDs, you’ll have to take periodic distributions, calculated using your life expectancy and account balance. Most plans send notifications before an employee turns 70½ that indicate the amount of the RMD.

Once you retire, should you roll your 401(k) nest egg over to an IRA, cash it out, leave it in the plan, or purchase an annuity? The easiest option is to simply leave your money in the 401(k) plan at your final employer and take distributions when you need them, allowing the rest of your money continue to grow, tax-deferred. With an IRA, you’ll have the same tax treatment as the 401(k), but with more flexibility and options, and you can consolidate all of your 401(k) accounts from past jobs into it. Another option is to rollover your savings into a tax-free annuity. Pensions and Social Security are two examples of lifetime guaranteed annuities. If you’re over 55 and no longer working, or are over 59½, then you can withdraw your entire 401(k) balance in one lump sum. The downside to this option is the severe tax consequence; the entire amount of money you withdraw would be taxed all at once. The key is to learn how to balance your withdrawal rate with your growth rate.

When deciding how much money to withdraw from your 401(k) plan each year, many financial advisors recommend the “4% rule”: withdrawing 4 percent annually to maintain financial security. Whether or not that amount will suit you depends on the retirees’ life expectancy, performance of investments, expenses, spouse, Social Security, and other factors. Whatever you do, it is extremely important to reevaluate your portfolio every year to make sure that your investments are still working well for you. Any retirement funds that are unused in your accounts after death will be passed on to your beneficiaries, and for this reason you should check your beneficiary information after any big life change.

401(k) plans remain a very popular option in retirement planning, though what’s best for you may be a combination of the options mentioned above. To decide, ask your employer’s plan administrator for details, and calculate your retirement earnings to get a sense of what you will need. The best course of action is to get advice from a financial professional. An advisor can help add value to your plan, assist with things like rollover decisions and help you create a portfolio that will work for you throughout your golden years.